Trademark license rights do not survive rejection by bankruptcy court

Trademark licenses are categorically unprotected from court-approved rejection during bankruptcy, unless and until Congress should decide otherwise, the United States Court of Appeals for the First Circuit, in a 2-1 decision has ruled, in a matter of first impression for the First Circuit. While the licensee still had its non-exclusive patent license rights, it lost both trademark rights and rights to exclusively distribute the debtor’s trademarked goods (Mission Product Holdings, Inc. v. Tempnology LLC), January 12, 2018, Kayatta, W.).

After filing a Chapter 11 bankruptcy proceeding on September 1, 2015, Tempnology, LLC ("Debtor"), a maker of specialized products—such as towels, socks, headbands, and other accessories—designed to remain at low temperatures even when used during exercise, rejected a 2012 agreement giving certain marketing and distribution rights to Mission Product Holdings, Inc. ("Mission"), through July 1, 2016. The parties agreed that Mission can insist that the rejection not apply to nonexclusive patent licenses contained in the rejected agreement. They disagreed as to whether the rejection applied to the agreement’s grant of a trademark license and of exclusive rights to sell certain of Debtor’s goods.

The First Circuit agreed with the bankruptcy court’s finding that Mission’s trademark rights and seller’s rights did not survive rejection of the agreement by the bankruptcy court. "We agree with the bankruptcy court that the rejection left Mission with only a pre-petition damages claim in lieu of any obligation by Debtor to further perform under either the trademark license or the grant of exclusive distribution rights."

Proceedings below. The day after filing for bankruptcy, the Debtor moved to reject seventeen of its contracts, including the agreement at issue on the appeal, pursuant to 11 U.S.C. § 365(a). The bankruptcy court found that section 365(n) only protected certain intellectual property rights, and Mission’s exclusive distributorship was not such a right. With respect to trademarks, the court reasoned that Congress’s decision to leave trademarks off the definitional list of intellectual properties in 11 U.S.C. § 101(35A) left the trademark license unprotected from rejection. Mission appealed to the Bankruptcy Appellate Panel ("BAP") which changed the reasoning and held that, because section 365(g) deems the effect of rejection to be a breach of contract, and a licensor’s breach of a trademark agreement does not necessarily terminate the licensee’s rights, rejection under 365(g) likewise does not necessarily eliminate those rights. The BAP followed a Seventh Circuit case. On appeal from the BAP, no deference is accorded their decision, but instead, the First Circuit reviewed and affirmed the bankruptcy court’s ruling.

The definition of "intellectual property." Under 11 U.S.C. § 101(35A), the term "intellectual property" means: (A) trade secret; (B) invention, process, design, or plant protected under title 35; (C) patent application; (D) plant variety; (E) work of authorship protected under title 17; or (F) mask work protected under chapter 9 of title 17. This is a specific list that does not include trademark or distribution rights. Section 365(n)(1)(B) allows Mission "to retain its rights (including a right to enforce any exclusivity provision of such contract…) under such contract and under any agreement supplementary to such contract, to such intellectual property (including any embodiment of such intellectual property to the extent protected by applicable nonbankruptcy law)." Mission argued that the words "any exclusivity provision of such contract" meant any "exclusivity provision" in the entire contract, whether or not the provision grants exclusive use of a pertinent intellectual property right.

The First Circuit disagreed. "Subsection (n)(1)(B) protects, for example, an exclusive license to use a patent, but does not protect an exclusive right to sell a product merely because that right appears in a contract that also contains a license to use intellectual property." The First Circuit declined to treat the right to sell a product as an enumerated "intellectual property" right, "merely because of a coincidental practical effect it may have in limiting the scope of the manner in which a patent might be exploited, especially where the Agreement itself expressly makes clear that any patent license is nonexclusive." Mission could not cite any cases to support its effort to paint its exclusive distribution right as a de facto exclusive intellectual property right. The language referring to an "embodiment" is something inherently limited in number, like a prototype.

Trademark rights. Congress in drafting section 101(35A) expressly listed six kinds of intellectual property, and intentionally excluded trademark licenses. This case did not present a request by a party, following rejection, to recover its own property from the hands of the debtor. "Rather, it presents a demand by a party to continue using the debtor’s property." There should not be broad equitable dispensations from section 365(a) rejections. The First Circuit rejected the Seventh Circuit’s approach which left in place the party’s right to continue using a trademark licensed to it under the rejected agreement. "Rejection converts the right into a pre-petition claim for damages," the court said. The effective licensing of trademarks, as opposed to other intellectual property rights, requires that the debtor monitor and exercise control over the quality of the goods sold to the public under cover of the trademark. "Trademarks, unlike patents, are public-facing messages to consumers about the relationship between the goods and the trademark owner. They signal uniform quality and also protect a business from competitors who attempt to profit from its developed goodwill." Failure of a debtor to police its trademarks could result in abandonment of its marks. For these reasons, trademark rights do not survive rejection, until Congress changes the law.

Dissenting opinion. Circuit Judge Torruella concurred in part, but disagreed with the majority’s bright-line rule that the omission of trademarks from the protections of section 365(n) leaves a non-rejecting party without any remaining rights to use a debtor’s trademark and logo. He would have followed the Seventh Circuit and the BAP in finding that Mission’s rights to use Debtor’s trademark "did not vaporize as a result of Debtor’s rejection of the executory contract." He relied heavily on the Senate report’s reference to equitable treatment of this situation by the bankruptcy courts. "As Congress has instructed the bankruptcy courts to do, the effect of Debtor's rejection on Mission's trademark license should be guided by the terms of the Agreement, and non-bankruptcy law, to determine the appropriate equitable remedy of the functional breach of contract."

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